Undercover Economist

The not-so-sweet smell of odious debt

A proposal that declares obligations of a particular regime non-transferable frees innocent people from indenture not of their making

“He that dies pays all debts,” says Stephano in The Tempest. Evidently he did not have sovereign debt in mind, which survives the demise of almost any government. Lucas Papademos would not get far with a declaration that, since Greece’s national debt had been accumulated by previous prime ministers, he had no obligation to pay it. That is not the way things are done: each government is liable for the deeds of its predecessors.

Usually this makes good sense, if only for the practical reason that without this principle of governmental succession, democracies would find it almost impossible to borrow money.

Yet the implications can be disturbing. Germany completed its reparation payments for the first world war in 2010. In South Africa in 1994, Nelson Mandela’s incoming government faced a debt burden of $23bn, in part courtesy of apartheid-era spending on the soldiers and police necessary to support the regime. Saddam Hussein bequeathed unpayable debts to Iraq.

For this reason, legal experts (for instance Lee Buchheit et al in the Duke Law Journal 2006) have pondered various doctrines of war debt, odious debt and hostile debt, under which certain kinds of debt – or perhaps all debts to certain kinds of government – might be written off. In 2008, the government of Ecuador did this unilaterally.

The trouble is that defining odious debt is contentious. Many governments that inherit odious debts pay them, figuring that the reputational benefits of doing so outweigh the costs (Mandela’s government is an example). Other governments may simply use the “odious debt” excuse to screw creditors, raising the cost of borrowing for governments in future – Ecuador’s default is cited as an example of this.

But there is an alternative. The idea was proposed by the economists Michael Kremer and Seema Jayachandran and has been taken up by the Center for Global Development, a think tank. The proposal is that the international community would declare that all future contracts with a particular regime would be non-transferable. Lend money to President Assad after such a declaration, and you can kiss goodbye to it if he is toppled; sign an oil-production sharing agreement with him at your own risk. (In practice, it is the US and UK, as hosts to most sovereign debt markets and courts, who would wield the biggest influence in such a declaration.)

This is an elegant idea. By drawing a clear line between existing debt, which is to be respected, and all future debt, which will be regarded as odious, it reassures creditors lending to the governments of poor countries. It frees innocent people from debts not of their making. And, cleverly, it undermines odious regimes by making it hard for them to promise credibly that they will repay their creditors.

Regular trade sanctions offer rich rewards to maverick states or private sector smugglers who circumvent them. An odious debt declaration is a kind of sanction that offers only headaches to the moneymen who might prefer to keep lending.

In truth, Damascus is already a pariah and has very little public debt, so this proposal is not relevant to Syria. But there are cases where the idea would have bite. Franco Tudjman’s government in Croatia, for instance, was cut off by the IMF in 1997, but turned to private creditors and almost quadrupled its borrowing that year. An odious debt declaration would have given those borrowers the creditors pause for thought.

Imposing sanctions of any kind is a policy with uncertain results. Yet a pre-emptive declaration of odious debt should at the very least make it harder for corrupt or repressive governments to borrow money. More to the point, it would mean that future generations were freed from the burden of loans that should never have been made.

Also published at ft.com.